What is the LP System?
An ETF liquidity provider (LP) should be an authorized participant (AP) approved for investment trading business and investment broker business and should be a settlement member of the exchange which has signed a liquidity provision contract with collective investment companies.
To list an ETF on KRX, a collective investment company should sign a contract with at least one LP, submit a liquidity provision contract to KRX, and also designate an employee who is in charge of liquidity provision business.
In addition, once KRX finds that an LP violated relevant laws and regulations in relation to liquidity provision business and received penalties, such as suspension of business or trading, or even higher penalties, the LP may not resume the liquidity provision business for one year from the moment.
Obligation to Submit Quotations
Basically, in the event that the quotation spread ratio {(Best Ask Price – Best Bid Price)/ Best Bid Price} exceeds 1%, an LP should fulfill its obligation by submitting two-way(Both Bid and Ask) quotation with at least of 100 shares accounts or more in five minutes.
LP should comply with such obligation constantly during the most of regular trading hour(from five minutes after the end of the opening single-price auction session until the start of the closing single-price auction session, 09:05 - 15:20). Since deals are made on the single price matched in the single-price auction sessions, LP is not obliged to submit quotes during this time.
In principle, an LP should submit both ask and bid prices at a time, but if the market spread ratio may fall into 1% or less with only one-way quotation (either ask or bid) submitted by the LP, the LP doesn't necessarily need to submit quotations for the other side. If there is no quotation in either ask or bid or both sides at all, the LP should provide quotation. At this time, if the LP submits ask quote or bid quote for the first time, it should submit a proper quotation considering NAV. This is because an LP is obliged to reduce not only the quote spread but also the disparate ratio, which is the difference between market price and NAV. In particular, the closing price disparate ratio is a legal obligation of LPs, The minimum quotation quantity an ETF LP can submit is 100 shares. As in the stock and ELW, market, the maximum quotation quantity is the quantity equivalent to 5% of the total number of listed shares or 0.1 billion shares, but block trading which does not impose an impact on the market is an exception.
Exemption from Submission of Quotation
As mentioned above, an LP does not need to submit quotations when the market spread ratio is less than 1%. An LP is not necessarily obliged to provide liquidity or make deals at any price investors want.
During the single-price auction session (Opening 08:00~09:00, Closing 15:20~15:30), and within 5 minutes after the end of the opening single-price auction session, an LP doesn't need to submit quotations. In other words, in the event that any reason for submitting liquidity occurs, the submission time is from 09:10 to 15:20. Of course, an LP can voluntarily submit quotations at anytime, and especially during the closing single-price auction, LP may submit both ask and bid quotations to fulfill its obligation of disparate ratio (1%).
In addition, an LP can be exempted from the obligation in the event of KRX approves that the market is in extraordinarily rapid change or other emergent situation.
Change of LPs
In the event that an LP has violated its obligation of liquidity provision for 20 trading days or more per quarter, KRX may request the collective investment company to change the LP. In this case, the collective investment company should change its LP within one month and unless it implements this, KRX can delist the relevant issue. In the event that the disparate ratio, which is the difference between the NAV of an ETF and the closing price, exceeds 3% for 20 business days or more per quarter, KRX may request the change of the LP. In addition, in the event that the days when the spread ratio requirement (1%) is violated for one hour or longer exceed 20 trading days or more per quarter, KRX can request the change of the LP.
Evaluation of LP and Provision of Support Fund
KRX runs the LP evaluation system to enhance the transparency of the ETF market and establish a competitive system among LPs. It announces the result of the evaluation so as to enhance the transparency of the market and the investor confidence. For this, KRX comprehensively evaluates various items, such as the level of fulfillment of obligations, voluntary quotation, average spread, and average quotation quantity, in order to promote competition among LPs, and provides inter-LP comparative evaluation data to investors. In addition, according to the result of the evaluation, the exchange provides a relevant amount of support fund to LPs as an incentive on a quarterly basis.